The Theory of Constraints (TOC) argues that good growth can be achieved by focusing on the one or two limiting factors or “Constraints” in a production system. This article applies the Theory of Constraints to the Wholesale / Retail sectors. If your business is in this sector, learn how the Theory of constraints can make a big impact on your profitability. All your other improvement efforts are likely to have less impact than applying the Theory of Constraints in the retail sector. The constraint, by definition, is your limiting factor.
What is Theory of Constrains in the Retail Sector About
Essentially, TOC says that most efforts should be devoted to identifying the (usually) single Constraint in a production system that limits the total throughput of that production system and then doing the best one can to reduce the impact of the Constraint.
Make sure you have read SM5.1 When a Bottleneck is Good – Theory of Constraints prior to reading the rest of this article. That article will give you the knowledge to find your constraint.
Once you are familiar with TOC, you can progress to the rest of this article.
In this example of an application of Theory of Constraints in retail, we talk mainly of retail but a similar thought process could apply to wholesale.
TOC has a five step process illustrated below.
1. Identifying a Retail Constraint
The sales process can be likened to a funnel. We tip customers in the top (referred to as “leads”) and they drop down through various purchase decision making stages, in the funnel, and eventually some proportion make a purchase. This is covered in more detail in the next article: SM5.3 TOC to Optimise Your Sales Funnel
Any one of these decision making points could be your constraint.
- Your product range is too limited.
- Your prices are too high.
- Your shop is not easily accessible.
- You don’t have the ‘hot’ new products in stock.
Ideally, you can identify the problem by checking at what stage customers leave the funnel but this is not always the easiest thing to do.
If you have a counter near the exit, you could ask people who didn’t purchase why not on their departure.
Perhaps the easiest bottle-neck/constraint/choke point to start with is getting more people (more leads) into the shop.
Certainly, one could argue that it is how much they buy, but if they don’t enter your shop to start with, they are not going to buy anything!
It is reasonable to assume that if people enter your shop, and consume around the average consumption of any single client, then simply getting more people to enter your shop would generate more sales.
2. Exploiting the System’s Constraint
In this stage, we use the Theory of Constraints in the retail sector to focus on things that might be done to relax the Constraint of how many shoppers come to the shop.
Arguably, this starts with the location of your shop. If you are in some obscure space, don’t have enough car parking or have some other “environmental” defect that limits the number of shoppers, you might need to give serious thought to re-locating the shop.
An alternative approach to location might be to either take the shop entirely onto the internet or to add more customers by adding an internet commerce arm to the business.
In any locality, word of mouth about the product range on offer within your shop will get around the community and will impact your shopper numbers.
In the early days of your shop, its future will somewhat be determined by the impact of the Diffusion of Innovation. Briefly, it says that the first 10% of shoppers (Very Early Product Adopters or VEPAs) that come to your shop will tend to govern how many of the remaining 90% of people will visit. If the VEPAs give you a good report, the next 25% of shoppers (Early Adopters) will come fairly easily. If they give you a bad report, not even the next 25% will come; let alone the remaining 90%.
Go to the article: Introducing the Diffusion of Innovation AKA Crossing the Chasm
We can turn our minds to what will attract and impress shoppers.
The things that tend to govern this are the normal things discussed in all Retailing literature, seminars and conferences. They include a proper and comprehensive range of merchandise applicable to the socioeconomic demographic of your shoppers and proper pricing. Proper pricing and proper display of goods all have a major impact on your shops appeal to customers and inducing them to enter to buy and come back to buy again.
An essential element of a successful exploitation of a shopper Constraint is that you always have an adequate supply of the fast selling and therefore most popular product lines. If a shopper visits to buy a particular trendy product, and finds that you do not have it, they will go elsewhere. Having gone elsewhere, they are likely to continue to shop in the business that was able to satisfy their need rather than return to you. The cost of running out of these fast running lines is very significant.
Go to the article: Cost of Under and Over Stocking
You should give thought to the likelihood of return traffic of satisfied customers.
You have already managed to get these shoppers to buy once which is the hard part.
If you can get them to return semi-regularly, you don’t have to pay for advertising to attract them again.
These people have a ‘lifetime’ value that greatly exceeds the value of their first purchase.
What do you do to get this return traffic?
- Do you get their contact information for your periodic email newsletter.
- Do you offer frequent buyer discounts.
- If they bring in a friend who buys, do you offer a discount.
- Have you got ‘mates rates’ that will bring them back.
If your shop sells products that are rarely purchased, your customers will rarely return. Unfortunately, people tend to forget after a certain period what their favourable impression was of your business. So, if they do not return on a regular basis they will tend to forget to come at all. Therefore, it might be advisable to ensure that your product range has some frequently purchased products, as well as the infrequently purchased products, so that people will get into the habit/routine of visiting your shop on a regular basis and become “bonded” to you.
It may be that shoppers are unaware of your business or what it has to offer. It may be a worthwhile investment to promote your business with periodic ‘sales’ and supporting advertising.
3. Subordinate Everything Else using the Theory of Constraints in Retail
Applying the Theory of Constraints in the retail sector tells us that if you accept the logic that the Constraint on your business is having the biggest impact, then it is foolish to divert resources to other parts of your business at the expense of focusing on reducing the impact of the Constraint.
On the face of it, this is a straight forward comment, but in reality, it takes a great deal of will power to focus on the Constraints and not to try and do the “best you can” at every product line and Retail department. This phenomenon is known as “Local Optima” and we talk more about its very significant impact and its wastefulness in the article: How to Manage Local Optima Problem
In Retail, one aspect of Local Optima is to obtain product at lower cost by making larger purchases. On the face of it, this is a rational decision because the price you pay per unit of the product you buy is cheaper because of the bulk discount.
In reality, it could easily be a false economy. For a start, you will have many products that you have paid cash for by paying the invoice to the supplier, but will sit on your shelves for an indefinite period (up to 80% of them according to The Amazing 80/20 Rule). This means that effectively the interest you are paying on the cash you used to buy the inventory is likely to quickly offset the savings that you made from the quantity discount.
Go to the Skills Module introduction: SM2.0 80/20 Sales Growth; Double Sales, Triple Profits
On the other side, it is very likely that you will continue to run out of very fast moving lines if you don’t take advantage of exploiting the power of keeping these high-volume lines readily available.
4. Elevate the Constraint
Once you have opened the volume of shoppers that are passing through your business, by always being able to provide them with attractively priced and merchandised product, you can give more thought to how you can improve the overall productivity and profitability of your Wholesale/Retail business.
Narrow your focus
This might take the form, within the existing business, of becoming more focused by reducing your product range to those 20% of the products that are likely to sell 80% of the volume. Within reason, increasing your focus/specialisation makes you more attractive to people looking for that product range and it makes it much easier for you to market your services because you only have one product range to focus on.
Consider the Specialist Store, with comparatively few product lines with enormous product range within each line, compared to a Department Store that has a smaller product range within any particular product line but many more product lines. Almost certainly the generalist (Department Store) will lose out to the Specialist Store whenever someone is searching for a comprehensive product range.
You can also think of elevating your shop’s constraint by “Scaling”.
By Scaling we mean growing the business in venues other than your existing store. A classic example of this is the Franchise model. Here, a successful single store reproduces their model by turning it into a package that can be sold to others to implement. You can consider Franchising by opening other stores under your own control and/or turning your business into a model that others can execute and take a share of their profit.
You can also Scale your business by taking it onto the internet.
Your own experience in your store will have indicated what product lines are in the most demand and therefore the ones that you can most readily service. Your own experiences also indicate that a focus on a particular product range (a specialist) is likely to be more successful than focusing on a wide range of products (a generalist). This lends itself to having a highly focused internet store selling just those comparatively few products that are highly popular and that you are good at selling. Some products of course will not lend themselves to internet commerce but if you can find ones that can be shipped widely – perhaps even world-wide if they are electronic – then your world is your oyster and you can Scale out of your existing business very successfully.
5. Be Alert to a Change in the Constraint
Once you have relaxed one Constraint, a different Constraint may pop up elsewhere and you will need to go after that one. This is still very productive because as you release each Constraint, your sales continue to go up.
We started this article by suggesting the number of people who visit your store might be the limiting factor or constraint. All things being equal, the more people in the door, the more your sales.
However, TOC will tell you that at some point your pool of potential shoppers might be exhausted so your constraint is no longer something inside your business. It becomes an external “market size” constraint. If you sell hearing aids, there are only so many locals who need one and you can’t just get more customers in the door.
Once you can’t see any way to improve on your current constraint, you might look elsewhere in your sales funnel in case you can, for example, increase the sales per customer with some changes. That might become your new constraint and you focus on that.
So far you have covered:
SM5.1 When a Bottleneck is Good – Theory of Constraints (TOC)
SM5.2 Theory of Constraints – Retail (you are here)
SM5.3 TOC to Optimise Your Sales Funnel
SM5.4 TOC Drum, Buffer, Rope Optimisation Technique
SM5.5 Demand Driven Materials Requirements Planning (DDMRP)